In the United States, our lawmakers created a pay-as-you-go tax system. What does that mean for you, the taxpayer? It means that you pay most of your taxes during the year, as the income is earned. Generally speaking, as taxpayers, we must pay at least 90 percent of our taxes throughout the course of the year. We do this by having taxes withheld from our paycheck or by making estimated tax payments quarterly, or by using a combination of the two payment methods. If quarterly estimated taxes are not paid during the year, you may incur an “estimated tax penalty” when the tax return is filed.
In recent history, the IRS has seen the number of estimated tax penalties rise, which means people are increasingly underpaying their taxes. In 2010, 7.2 million incurred this tax penalty and in 2017, that number jumped to 10 million, an increase of 39% in 7 years! Penalty amounts may vary, but the typical penalty is 0.5 percent of the total amount you owe calculated for each month you haven’t paid it.
In December 2017, the “Tax Cuts and Jobs Act” was enacted. This new tax law changed the income tax calculations for almost all taxpayers, meaning calculations for quarterly estimated tax payments also changed. Many taxpayers were caught by surprise, discovering they had not withheld and paid enough in estimated taxes. Fortunately, for the 2018 tax year, the IRS waived estimated tax penalties for those who filed a Form 2210 and who had paid at least 85% of their total tax liability during the year. This relief was granted specifically to help taxpayers who were unable to properly adjust their withholding and estimated taxes to reflect the changes from the new tax law. However, this relief will not extend into 2019 as far as we know.
Who needs to withhold their own quarterly estimated taxes and pay them quarterly?
If you are an individual, sole proprietor, partner in an LLC, or S-corporation shareholder, you may need to make estimated tax payments if:
- you expect to owe at least $1,000 when you file the return you owed the IRS money in the previous year.
Also, you may need to make estimated tax payments if:
- you receive income that isn’t from an employer, such as interest, dividends, alimony, capital gains, prizes and awards.
- you didn’t have enough income tax withheld from your salary or pension,
- you have more than one job, but don’t have each employer withhold taxes
- you are self-employed
- you are is a direct-sales rep or have in-home-sales company
- you participate in sharing economic activities where you are not working as an employee
When are estimated taxes supposed to be paid?
The year has four payment periods. You must make a payment every quarter. Normally the due date for the first quarterly payment is April 15th, and then June 15, and September 15th, with the last installment due on January 15th of the following year. If any of these dates fall on a weekend or holiday, then, the deadline is typically the next business day. You may pay by mail or online. It is also okay to make payments more often than quarterly, as long as you pay the total amount due at each quarterly payment.
Penalties for Failure to Pay Estimated Taxes Quarterly
If your taxes are underpaid, you may have to pay a penalty to the IRS, regardless if you paid through withholding or through estimated quarterly tax payments. If you are tardy with paying your quarterly taxes, then you may also be hit with a penalty, even if you are due a refund at filing time. To see whether you owe a penalty, use Form 2210.
However, in general, you will not incur penalties if you owe less than $1,000 in taxes or if throughout the year, you paid the smaller of these two amounts:
- at least 90% of your taxes for the current year (however, see 2018 Penalty Relief, below)
- 100% percent of tax due on your tax return for the prior year (Please note: based on adjusted gross income, this number can increase to 110%)
If you underpaid because of an unusual circumstance(s) (not “willful neglect”), then the IRS can waive the penalty. Examples include:
- casualty, disaster or other unusual situation
- you retired after reaching age 62 during a tax year when estimated tax payments applied
- You became disabled during a tax year when estimated tax payments applied
Is there any way to avoid having to pay estimated taxes each quarter?
If your income consists of paychecks from an employer, to avoid having to make estimated tax payments, make sure your employer(s) withhold the correct amount of tax from your wages. The IRS provides a “withholding calculator,” so you can determine the right amount to withhold. Using the recommendations from the IRS’s calculator, you can fill out a Form W-4 (Employee’s Withholding Allowance Certificate) to inform your employer about how much they should be withholding from each paycheck you receive. Changing your withholdings any time during the year is not a problem.
How to figure out if your employer is withholding enough
The IRS recommends doing a paycheck checkup now, even if you did one in 2018, to determine if you need to adjust your tax withholdings or make estimated tax payments. This is imperative for anyone who owed taxes in 2018. It’s also important for anyone whose refund was different from what was expected. Do the checkup and make any necessary changes now, so you can ensure you get the refund you want next year and, if you owed the IRS money in 2018, then making estimated tax payments in 2019 is the best way to ensure you won’t be hit with an unwanted surprise at tax-time next year.
During the year, if changes in your financial situation occur, or you experience life events such as marriage or the birth of a child, it is important to make the necessary adjustments. Keep in mind you should also adjust for the recent changes to the tax law.
If you are not having estimated taxes withheld by an employer, what do you do?
If you do not receive a paycheck from an employer who withholds and pays quarterly for you, it is up to you to calculate the proper amount to pay to the IRS each quarter. The safest approach is to withhold and pay 110% of what you paid in taxes last year, assuming your income hasn’t increased substantially (e.g. assuming your “adjusted gross income” will remain basically the same) and your circumstances have not changed significantly. You divide that amount by four and pay each quarter. If you need help calculating, you can look to the IRS’s Publication 505 and its Form 1040-ES to calculate what you should withhold. Both are available on the IRS website. See https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes and Tax Withholding and Estimated Tax (Publication 505), for more info.
If you earn unevenly during the year, paying estimated taxes quarterly can be a challenge. For example, a boat repair business might bring in increased revenue in the summer. Thankfully, you can annualize your income. Basically, you make unequal quarterly tax payments, based on when you receive income, rather than making four even payments. Use Worksheet 2-9 in Publication 505, because your required payment for one or more periods may be higher with this method.
A possible trap for the unwary
In January of 2018, the IRS released updated federal tax withholding tables which reflected the new tax law’s lower tax rates and the increased standard deduction. In 2018, many taxpayers saw less tax withheld and therefore more money in take-home pay. However, the new withholding tables didn’t fully factor in other changes, such as the suspension of dependency exemptions, and the lowering of itemized deductions.